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CORPORATE GOVERNANCE IN USA; CORPORATE GOVERNANCE PROJECT Submitted By: Name: - Shariq Ahmad Saroori. Course: - BA, LLB (H). Sec: - B. Semester: - 9 th. Enrollment No: - A3211110132. Subject: - Corporate Governance in USA; Corporate Governance Project. Submitted to: - Mr. Ajay Kant Chaturvedi Sir. DECLARATION BY STUDENT I hereby declare that the project entitled “Corporate Governance in USA” submitted for BA, LLB (H) external evolution of Amity Law School, Amity University, Noida is my original work. Signature of the student Shariq Ahmad Saroori ACKNOWLEDGEMENT I am highly indebted to (Mr. Ajay Kant Chaturvedi Sir) for guidance and constant supervision as well as for providing necessary information regarding the project & also for their support in completing the project. I would like to express my gratitude towards my parents & my sister for their kind co-operation and encouragement which help me in completion of this project. I would like to express my special gratitude and thanks to Amity Law School, Noida campus for giving me such attention. My thanks and appreciations also go to my colleague in developing the project and people who have willingly helped me out with their abilities. PREFACE I am glad to present this project, especially designed to serve the needs of the General people. The project has been written keeping in mind the general weakness in understanding the fundamental concepts of the topics. The project is self-explanatory and adopts the “Teach Yourself” style. The language of project is quite easy and understandable based on scientific approach. Any further improvement in the contents of the project by making corrections, omission and inclusion is keen to be achieved based on suggestions from the readers for which the author shall be obliged. I look forward to receiving valuable suggestions from professors of various educational institutions, other faculty members and students for improvement of the quality of the project. Shariq Ahmad Saroori Introduction: Understanding Corporate Governance in the USA The U.S. is often seen as being the paradigmatic case of the shareholder-oriented or market- based approach to corporate governance. Ownership of corporations is dispersed, but involves high engagement from institutional investors, such as pension funds. Corporate boards are small, have a high proportion of outside or independent members, and utilize committees to improve board processes. Executive pay links pay to top managers‟ salaries to shareholder returns. The internal and external aspects of corporate governance are linked through the monitoring of gatekeepers, such as audit firms, that certify the flow of information from managers to capital markets. And the market for corporate control exerts a final discipline on poorly performing firms, who face a heightened risk of takeover. These different elements are also thought have strong institutional complementarities, operating as a positive and mutually reinforcing system of effective corporate governance. These stylized characteristics of the U.S. model are widely cited as best practices or even a global standard for good corporate governance. Scandals surrounding Enron and World com focused substantial criticism on the U.S. corporate governance. Some critics and scholars used these events to mount a strong challenge to the prevailing wisdom about market-based systems of corporate governance (Blair, 2003, Bratton, 2002). Others stress the overall good performance of the U.S. economy, and see the rise of equity-based pay for managers and the stock market boom as triggering short-term and sometimes illegal behavior as “side effects” of a basically sound system (Holmstrom & Kaplan, 2003). The political reaction, development of Sarbanes Oxley (SOX) legislation, and subsequent changes in SEC listing requirements have also altered the way U.S. corporate governance practices operate. The consequences of SOX have remained hotly debated. Yet the onset of the subprime financial crisis and resulting global economic downturn has raised renewed questions about the fundamental effectiveness of U.S. corporate governance institutions. The era after SOX also greatly increased awareness of the differences between the U.S. and British approaches to corporate governance. While both are considered to be broadly similar shareholder-oriented models, the U.S. regulatory regime is based much more on hard law and a regulatory state, unlike the British approach that relies more on soft law and self-regulatory mechanisms, such as Codes. The “one size fits all” approach of U.S. law sparked debate over the benefits of mandatory rules relative to more flexible sets of principles based on enabling set of rules (Anand, 2006). New U.S. regulation gives greater power and institutional scope to the state agencies such as the SEC to regulate important „gatekeepers‟ and professional intermediaries who are central to market-based mechanisms of monitoring (Baker, Bealing Jr, Nelson & Staley, Understanding Corporate Governance in the United States Finally, takeover rules are also very different, since the U.S. allows but regulates a range of anti- takeover defenses, which are not allowed under UK rules. Recent developments remind us that U.S. corporate governance is not a static system in equilibrium, but has evolved continuously over the past decades. Prior to the 1980s, the U.S. was characterized by strong managers and weak owners. Top managers tended to view themselves as loyal to the corporation, rather than as agents of shareholders. The 1980s saw a huge wave of hostile takeovers that threatened the hegemony of U.S. managers. Likewise, institutional investors and particularly public-sector pension funds such as CALPERs became much more active players in corporate governance, using their growing blocks to exercise greater voice in corporate management (Useem, 1996). By the 1990s, managers had fought back by lobbying state governments to en- act anti-takeover legislation, which made hostile takeovers much more costly (Useem, 1993). But managers also accepted the notion of “shareholder value” as a new underlying ideology for corporate America. In particular, the rise of equity-based pay such as stock options gave managers a greater stake in promoting restructuring and orientating their strategies toward the stock market. This shift went hand-in-hand with the catalysed role of independent, outside directors in the boardroom (Gilson, 2006). This system continues to evolve today. This Report to the Hans-Boeckler-Foundation aims to outline the long-term changes in the U.S. system of corporate governance that culminated in SOX legislation and continue into the current period of the financial crisis. The report will also highlight some implications for corporate governance debates in Germany, either by the direct application of U.S. rules to German companies or indirectly by setting symbolic bench- marks for corporate governance reform. The main findings highlighted in the report are as follows: The various elements of the U.S. corporate governance system have emerged in a piecemeal historical fashion, often showing substantial misalignment among its various elements leading to waves of speculative activity (e.g. junk bonds, the dot. com bubble, and collateralized debt obligations) and subsequent collapse; the crisis of Enron substantially altered the understanding of how the U.S. corporate governance system operates in the academic literature; the regulatory response of SOX has sharpened the differences between U.S. and British approaches; SOX legislation has made some genuine, if costly improvements regarding the role of gatekeepers, but has not fundamentally altered the weak linkages among limited shareholder engagement, excessive managerial incentives for risk taking, and conflicted role of independent directors within U.S. boards; Overall, the market for corporate control may play a lesser role within the U.S. than is often hypothesized based on the experience of the 1980s. THE US MODEL The corporate governance system in USA is based on shareholder wealth maximization principles. The governing / influencing statutes / bodies include the Sarbanes-Oxley Act of 2002 (SOX), Securities & Exchange Commission (SEC) and guidelines of the stock exchanges like NASDAQ, NYSE etc. In addition, court judgments in various States are also relevant because US corporations are registered in particular States. USA being an intensely capitalistic society, other stakeholders like creditors are not materially considered and do not have much say. This could be because all the other stakeholders are themselves governed by their own shareholders or owners. It is expected that shareholders of the stakeholders will suitably take care of their interests. In the US model, there is separation of ownership and management to the extent that managers have a free hand in running the affairs of the organization. The Non Executive Directors monitor the performance of these managers (who may themselves be Executive Directors) and take appropriate action to encourage or discourage the strategies being attempted by them. The board is a single tier body with Executive & the Non-Executive Directors coming together to chart the course of the organization. The primary duty of the independent Directors is the oversight of all activities of the Management board. In most cases, one of the Executive Directors, who is the Chairman, is also the Chief Executive Officer of the organization. Managers are considered as agents of the owners and hence the Non-Executive Directors / Board may terminate these “agency contracts” in case of poor performance. On the other hand, these managers get rewarded for good performance, through bonuses and “free” stake in the organization through stock options etc. Of course, this leads to short-term orientation and a “micro” mindset of the managers in some cases. Mechanisms are being created to factor the impact of these stock options on the profit & loss statements of companies. The ownership patterns of US organizations are such that they are widely held and capital is provided by people who are not involved in day to day management of the organization. The large institutional investors (mutual funds, pension funds etc.) are having maximum stake in these organizations and the capital markets are more liquid as equity is the preferred mode of business funding. As an example, Citigroup Inc. (NYSE:C) has a single tier board structure with several Committees for managing the governance affairs and for oversight of management. As per the corporate governance guidelines of Citigroup, the standing committees of the Board are the Executive Committee, the Audit Committee, the Personnel and Compensation Committee, the Nomination, Governance and Public Affairs Committee and the Risk Management and Finance Committee. The presence of these Committees highlights the critical areas requiring supervision by the board. The philosophy of Citigroup Inc. (NYSE:C) emphasizes its focus on shareholder‟s interests. As per the guidelines of the company, “the Board of Directors‟ primary responsibility is to provide effective governance over the Company‟s affairs for the benefit of its stockholders, and to consider the interests of its diverse constituencies around the world, including its customers, employees, suppliers and local communities”. The board keeps a close tab on the functioning of the management and the recent exit of CEO of the company (Vikram Pandit), was reported to be a case of the board being dissatisfied with management‟s strategic management approach. Other companies like Bank of America Corp (NYSE:BAC) have similar board structures and committees. In the USA, the rules emphasize compliance & disclosures with penalties for any deviation from the rules. The system is extremely strict with very little tolerance for avoidance. In fact, the SOX was a reaction to various frauds in firms like Enron, Adelphia, WorldCom etc. which originated due to laxity in the accounting & auditing systems. SOX emphasizes on financial disclosure, independence of audit, criminal liability for incorrect financial statements etc. In USA it is mandatory for companies which want to be listed to have an audit committee in the board which interacts with the external auditors, ensures proper financial reporting / disclosures, risk management etc. This Committee comprises of Non-Executive Directors and has at least one financial expert so that the system of internal financial control is continuously practiced and improved. This committee furthers the principles of separation of ownership and management. The corporate Governance model in UK is pretty much similar to the US system and hence differs from the models prevalent in Continental Europe. Conclusion and Implications for Understanding Corporate Governance Corporate governance practices in the United States are not regulated by any one particular statute but instead are affected by the governing instruments, the corporate law and the court decisions of each issuer‟s state of incorporation, and, in the case of many publicly-owned issuers, by the U.S. federal securities laws and requirements of the national securities markets. Matters governed by state law include the voting rights accorded to shareholders, the functions of the board, and the ability of board members and executives to enter into transactions with the company. State corporation laws vary among the 50 states. However, because many corporations choose to incorporate in Delaware, Delaware law is a useful reference point for state corporate governance practices and is referred to throughout this response. U.S. federal securities laws also affect corporate governance practices, primarily in the areas of disclosure and financial reporting, proxy voting, and the submission of shareholder proposals for consideration at shareholders‟ meetings. In addition, the national securities markets impact corporate governance practices through their requirements applicable to issuers of securities traded on their markets. Subject to all of these different laws and regulations as applicable, corporations may establish their own governance practices in their corporate charters and by laws. BIBLIOGRAPHY TEXT BOOK  International Corporate Governance: A Comparative Approach Hardcover by Thomas Clarke.  Macmillan Dictionary. WEBSITES  